CHAPTER
4
Financial Forecasting,
Planning, and Budgeting
CHAPTER ORIENTATION
This chapter is divided into two sections. The first
section includes an overview of the role played by forecasting in the firm's
planning process. The second section focuses on the construction of detailed
financial plans, including developing a cash budget for future periods of the
firm's operations. A budget is a forecast of future events and provides the
basis for taking corrective action and can also be used for performance
evaluation. The cash budget also provides the necessary information to estimate
future financing requirements of the firm. These estimates are the key elements
in our discussion of financial planning and budgeting.
CHAPTER OUTLINE
I. Financial forecasting and planning
A. The need for forecasting in financial management arises
whenever the future financing needs of the firm are being estimated. There are
three basic steps involved in predicting financing requirements.
1. Project the firm's sales revenues and expenses over the
planning period.
2. Estimate the levels of investment in current and fixed
assets, which are necessary to support the projected sales level.
3. Determine the financing needs of the firm throughout the
planning period.
B. The key ingredient in the firm's planning process is the
sales forecast. This forecast should reflect (l) any past trend in sales that
is expected to continue and (2) the effects of any events, which are expected
to have a material effect on the firm's sales during the forecast period.
C. The traditional problem faced in financial forecasting begins
with the sales forecast and involves making forecasts of the impact of
predicted sales on the firm's various expenses, assets, and liabilities. One
technique that can be used to make these forecasts is the percent of sales
method.
1. The percent of sales method
involves projecting the financial variable as a percent of projected sales.
2. As sales volume changes, the level of
assets required to support the firm changes.
Assets are financed by liabilities and equity, so changes in assets lead
to changes in liabilities and equity.
Current liabilities, such as accounts payable and accrued expenses, vary
spontaneously as sales change. Retained
earnings are impacted by changes in net income and dividends.
3. The difference between the projected
level of assets and the projected change in liabilities and equity is the
discretionary financing needed.
4 Percent of sales forecasting can give
erroneous results for assets that have scale economies or assets that must be
purchased in discrete quantities.
II. Sustainable rate of growth
A. Sustainable rate of growth indicates how
fast a firm can grow without having to increase the firm’s debt ratio and
without having to sell more stock.
B. Sustainable rate of growth, g = return
on equity x (1 – dividend payout ratio)
III. Financial planning and budgeting
A. Three functions of a budget are
indicating the amount and timing of future financing needs, providing the basis
for taking corrective action if actual figures do not match budget estimates,
and evaluating performance of the firm.
B. The cash budget represents a detailed
plan of future cash flows and can be broken down into four components: cash
receipts, cash disbursements, net change in cash for the period, and new
financing needed.
C. Although no strict rules exist, as a
general rule, the budget period shall be long enough to show the effect of
management policies, yet short enough so that estimates can be made with
reasonable accuracy. For instance, the
capital expenditure budget may be properly developed for a 10-year period while
a cash budget may only cover 12 months.
D. Cash budgets can be used to develop a pro forma income
statement and a pro forma balance sheet.
1. A pro forma income
statement represents a statement of planned profit or loss for the future
period and is based primarily on information generated in the cash budget.
2. The pro forma balance sheet for a future date is
developed by adjusting present balance sheet figures for projected information
found primarily within the cash budget and pro forma income statement.
ANSWERS TO
END-OF-CHAPTER QUESTIONS
4-1. This rather simplistic forecast method assumes no other
information is available which would indicate a change in the observed
relationship between sales and the expense item, asset or liability being
forecast. Furthermore, the percent of
sales method works best for projected sales levels that are very close to the
base level sales used to determine the "percent of sales." The greater the difference in predicted and
base level sales, in general, the less accurate will be the percent of sales
forecast.
4-2. In a fixed cash budget, cash flow estimates are made for a
single set of sales estimates, whereas a variable budget involves the
preparation of several cash flow estimates, with each estimate corresponding to
a different set of sales estimates.
4.3 A flexible (or variable) cash budget gives the firm's
management more information regarding the range of possible financing needs of
the firm, and secondly, it provides management with a standard against which it
can measure the performance of those subordinates who are responsible for the
various cost and revenue items contained in the budget.
4-4. The probable effect on cash flows would be as follows:
(a) increased cash inflow from sales but increased cash outflow
to finance needed increases in inventories and other assets.
(b) increased supply of available cash.
(c) decreased cash inflow.
(d) immediate decrease in cash inflows (or a cash outflow).
4-5. As a general rule, the budget period should be long enough to
show the effect of management policies yet short enough so that estimates can
be made with reasonable accuracy. Since
some budgets, such as capital expenditure budgets, require long-range planning
in order to be effective while other budgets are more effective for shorter
periods, it would not be wise for a firm to establish a standard budget period
for all budgets. Instead, firms usually
have a minimum of two and sometimes three types of budgets. The short-term budget is very detailed and
includes a cash budget covering 6 months to a year. The intermediate term budget will contain pro
forma statements and verbal descriptions of major investment/financing plans
that cover 2 to 5 years. A long-term
plan would involve less detailed general statements about the firm's strategic
plans covering the next 3 to 10 years.
4-6. A cash budget can also be used to determine the amount of
excess cash on hand that will not be needed to finance future operations. This excess cash can then be invested in
securities or other profitable alternatives.
4-7. The careful budgeting of cash is of particular importance to a
seasonal operation because cash flows are not continuous. The availability of cash resources must be
carefully planned in order that the normal operation of the firm can be
continued during slow periods. In
addition, it is important to plan for future cash needs so that excess funds
may be invested.
SOLUTIONS
TO
END-OF-CHAPTER
PROBLEMS
Solutions to Problem Set A
4-1A.
2003 % of Sales 2004
Sales 12,000,000 15,000,000
Net Income 1,200,000 2,000,000
Current Assets 3,000,000 25% 3,750,000
Net fixed assets 6,000,000 50% 7,500,000
Total Assets 9,000,000
11,250,000
Liabilities and Owner's Equity
Accounts payable 3,000,000 25% 3,750,000
Long-term debt 2,000,000 NA 2,000,000
Total Liabilities 5,000,000 5,750,000
Common stock 1,000,000 NA 1,000,000
Paid-in capital 1,800,000 NA 1,800,000
Retained earnings 1,200,000 3,200,000
Common equity 4,000,000 6,000,000
Total Liabilities and Equity 9,000,000
11,750,000
DFN
= (500,000)
4-2A.
a. %
Credit Sales 0.5
Sales
February 20,000
March 30,000
April
(estimated) 40,000
Accounts
receivable (3/31/03) 20,000
plus
credit sales for April (50% x 40,000) 20,000
less
collections from Feb sales (50% x 20,000 x .5) (5,000)
less
collections from March sales(50% x 30,000 x .5) (7,500)
Accounts
receivable (4/30/03) 27,500
b. Collections
From:
April cash sales $
20,000
February credit sales 5,000
March credit sales 7,500
$
32,500
4-3A. Based upon the projections made, Sambonoza can expect to have
total assets next year equal to $1.8 million made up of the $1 million in fixed
assets plus $800,000 (.2 x $4 million) in current assets. These assets will be financed by known
sources of funding comprised of $900,000 in common equity [$800,000 +
(.5)(.05)($4 million) = $900,000], plus payables and trade credit equal to 10%
of projected sales ($400,000) which totals $1.3 million. This leaves $500,000 ($1.8 million - $1.3
million), which will need to be raised to meet the financing needs of the
firm.
4-4A. Instructor’s Note:
This is an introductory percent of sales financial forecasting
problem. Students should be able to
solve it after a first reading of the chapter.
(a) Projected Financing Needs = Projected Total Assets
= Projected Current Assets +
Projected Fixed Assets
={ x $20 m} +{ $5m + $.1m} = $11.77m
(b) DFN = Projected
Current Assets + Projected Fixed Assets
-
Present LTD - Present Owner's Equity
- [Projected Net
Income -
Dividends]
- Spontaneous
Financing
={
x $20m} + $5.1m - $2m -
$6.5m
-
[.05 x $20m - $.5m] -{ x $20m}
DFN
= $6.67m + $5.1m - $8.5m - $.5m - $2m = $.77m
(c) We first solve for the maximum level of sales for which DFN =
0:
DFN = (
- .05 - 
) Sales –
(5.1M-2M-6.5M +.5M)
- .05 - ) Sales –
(5.1M-2M-6.5M +.5M)
DFN = .1833 SALES - $2.9M = 0
Thus, SALES = $15.82M
The largest increase in sales that
can occur without a need to raise "discretionary funds" is
$15.82M
- $15M = $820,000.
4-5A.
Cash $ .1m Current Liabilities $.6m
Accounts Receivable .1m Long-Term Debt .4m
Inventories 1.0m Common Stock plus
Net Fixed Assets .8m Retained earnings 1.0m
$2.0m $2.0m
4-6A. (a) The Sharpe
Corporation Cash Budget Worksheet
Nov Dec Jan Feb Mar Apr May June July
Sales $220,000 $175,000 $ 90,000 $120,000 $135,000 $240,000 $300,000 $270,000 $225,000
Collections:
Month of sale (10%) 9,000 12,000 13,500 24,000 30,000 27,000 22,500
First month (60%) 105,000 54,000 72,000 81,000 144,000 180,000 162,000
Second month (30%) 66,000 52,500 27,000 36,000 40,500 72,000 90,000
Total Collections 180,000 118,500 112,500 141,000 214,500 279,000 274,500
Purchases 72,000 81,000 144,000 180,000 162,000 135,000 90,000 75,000
Payments (one month lag) 72,000 81,000 144,000 180,000 162,000 135,000 90,000
Cash Receipts
(collections) 180,000 118,500 112,500 141,000 214,500 279,000 274,500
Cash Disbursements
Purchases 72,000 81,000 144,000 180,000 162,000 135,000 90,000
Rent 10,000 10,000 10,000 10,000 10,000 10,000 10,000
Other Expenditures 20,000 20,000 20,000 20,000 20,000 20,000 20,000
Tax Deposits 22,500 22,500
Interest on Short-Term
Borrowing _______
_______ _______ _______
605 386
_______
Total Disbursements $102,000 $111,000 $196,500 $210,000 $192,605 $187,886 $120,000
Net Monthly Change $78,000 $7,500 ($84,000) ($69,000) $21,895 $91,114 $154,500
Beginning Cash Balance 22,000 100,000 107,500 23,500 15,000 15,000 67,509
Additional Financing
Needed (Repayment) ________ _______ ________ 60,500 (21,895) (38,605) _______
Ending Cash Balance $100,000 $107,500 $ 23,500 $15,000 $ 15,000 $ 67,509 $222,009
Cumulative Borrowing 0 0 0 $ 60,500 $ 38,605 0 0
(b) The firm will have sufficient funds to
cover the $200,000 note payable due in July.
In fact, if the firm's estimates are realized they will have $222,009 in
cash by the end of July.
4-7A.
Cash YES1
Marketable Securities NO
Accounts Payable YES
Notes Payable NO2
Plant and Equipment NO3
Inventories YES
1 Cash receipts follow sales with a
lag related to the payment habits of the firm's customers and the firm's policy
regarding payments on its accounts payables.
2 Notes payable may well follow
sales if the firm uses a line of credit to finance its working capital needs
(discussed later in Chapter 18).
3 The answer depends on whether or
not the firm has excess capacity. If
there is excess capacity, plant and equipment will not vary directly with the
level of firms sales. If there is no
excess capacity, plant and equipment will vary directly.
4-8A.
(a)
Current assets1 $16m Accounts payable2 $
8m
Net fixed assets 15m Notes payable3
3m
$31m Bonds payable 10m
Common
equity 10m
$31m
____________
1x $80m = $16m
2x $80m = $ 8m
3$31m
- $28m = $ 3m (Balancing figures
which equal estimated discretionary financing needs in 2004)
____________
(b) = -
-
bonds -
= $31m - $8m - $10m - $10m
= $3m
(c) See answer to question 4-1.
Instructor’s Note: This problem follows the text example very
closely and provides an excellent assigned exercise to accompany a first
reading of the chapter.
4-9A.
(a) Estimating
Future Financing Needs
Armadillo Dog Biscuit Co., Inc.
Projected Need for Discretionary
Financing
Present % of Sales Projected
Level
Level ($5m)
(Based on $7m
Sales)
Current Assets $2.0m = .40 or 40% .40 x $7m = $ 2.8m
Net Fixed Assets $3.0m = .60 or 60% .60 x $7m = $ 4.2m
Total $5.0m $
7.0m
Accounts Payable $.5m = .10 or 10% .10
x 7m = .7m
Accrued Expenses $.5m = .10 or 10% .10 x 7m = .7m
Notes Payable1 ------ ----- Plug Figure = 1.11m
Current Liabilities $1.0m $
2.51m
Long-Term Debt $2.0m No Change $2.00m
Common Stock .5m No Change .50m
Retained Earnings 2 1.5m $1.5m + .07 x $7m = $
1.99m
Common Equity $2.0m $2.49m
Total $5.0m $
7.00m
1 Notes payable is a balancing figure which
equals discretionary financing needed, DFN, which equals: Total Assets - Accounts Payable - Accrued
Expenses - Long-Term Debt - Common Stock - Retained Earnings = $7.0m - $0.7m -
$0.7m - $2.0m - $0.5m - $1.99m = $1.11m.
2 The projected retained earnings is the
sum of the beginning balance of $1.5m plus net income for the period (.07 x
$7m).
(b) Before After
Current Ratio =
2 times =
1.12 times
Debt Ratio =
.60 or 60% =
.644 or 64.4%
The growth in the firm's assets (due to the
projected increase in sales) was financed predominantly with notes payable (a
current liability). This led to a
substantial deterioration in both the firm's liquidity (as reflected in the
current ratio) and an increase in its use of financial leverage.
(c) The slower rate of growth in sales would
have allowed Armadillo to finance a larger portion of the funds needed using
retained earnings. For example, using
the 7 percent net profit margin Armadillo would have .07 x $6m = $420,000 it
could reinvest after one-year's operations plus .07 x $7 million = $490,000
from the second year's sales. The total
amount of retained earnings over the two years then would be $910,000 rather than
only $490,000 as before. This would mean
that notes payable would be $380,000 after one year, and only $1.11m - .42m =
$690,000 at the end of the second year.
The resulting level of current liabilities would be $2.09m. Thus, the post sales growth current ratio
after two years would be 1.34 ($2.8m/2.09m = 1.34) compared to 1.12 with a
one-year growth period. The debt ratio
under the two-year growth period will be only 58% compared to approximately 64%
with the single year growth period. The
slower growth pace would allow the firm to expand its assets more gradually,
thus requiring less external financing since more earnings can be
retained.
4-10A.
Instructor’s Note:
This problem differs from the text discussion of "discretionary
financing needed" in that it relies on the projected change in
assets rather than the projected level of total assets. Under these circumstances DFN = DTA - DSL - DRE where DTA = the projected change
in total assets, which is the amount of new financing needed (in total);
DSL = the projected change
in spontaneous liabilities; and DRE = the projected change in retained
earnings that will be available to finance a portion of the firm's needs for
new funds.
First, we estimate that the
projected change in assets during the coming year will be:
DTA = .30 DSales
= .30 ($500,000) = $150,000
Thus, total new financing of
$150,000 must be obtained during the next year to support the growth in firm
sales.
Next, we project the change in
spontaneous liabilities (DSL)
DSL = .15 DSales
= .15 ($500,000) = $75,000
Finally, we project new retained
earnings (DRE) that will be available to
help finance the firm's operations during the next year,
DRE = New Income - Dividends
= .05 x Projected Sales - .04 x Projected
Sales
= .01 ($5,500,000)
DRE = $55,000
Discretionary Financing Needed
(DFN) can now be calculated as follows:
DFN = DTA - DSL - DRE
= $150,000
- 75,000 - 55,000
= $20,000
Note that this problem solution
works with the change in financing needs rather than totals. The same solution would result if we
projected total assets, total spontaneous financing, etc. However, in this problem we do not know the
existing levels of the assets, liabilities and owners' equity accounts. Thus, we cannot use this latter approach to
solve the problem.
4-11A
a. Projections based on expected sales
levels:
Nov
|
Dec
|
Jan
|
Feb
|
Mar
|
Apr
|
May
|
June
|
July
|
August
|
|
Sales
|
220,000
|
175,000
|
100,000
|
120,000
|
150,000
|
300,000
|
275,000
|
200,000
|
200,000
|
180,000
|
Collections:
|
||||||||||
Month of sales (20%)
|
20,000
|
24,000
|
30,000
|
60,000
|
55,000
|
40,000
|
40,000
|
|||
First month (50%)
|
87,500
|
50,000
|
60,000
|
75,000
|
150,000
|
137,500
|
100,000
|
|||
Second month (30%)
|
66,000
|
52,500
|
30,000
|
36,000
|
45,000
|
90,000
|
82,500
|
|||
Total collections
|
173,500
|
126,500
|
120,000
|
171,000
|
250,000
|
267,500
|
222,500
|
|||
Purchases
|
65,000
|
78,000
|
97,500
|
195,000
|
178,750
|
130,000
|
130,000
|
117,000
|
0
|
|
Payments
|
65,000
|
78,000
|
97,500
|
195,000
|
178,750
|
130,000
|
130,000
|
117,000
|
||
Cash
Receipts
|
173,500
|
126,500
|
120,000
|
171,000
|
250,000
|
267,500
|
222,500
|
|||
Cash
Disbursements --
|
||||||||||
Purchases
|
78,000
|
97,500
|
195,000
|
178,750
|
130,000
|
130,000
|
117,000
|
|||
Rent |
10,000
|
10,000
|
10,000
|
10,000
|
10,000
|
10,000
|
10,000
|
|||
Other expenditures
|
20,000
|
20,000
|
20,000
|
20,000
|
20,000
|
20,000
|
20,000
|
|||
Tax Deposits
|
22,500
|
22,500
|
||||||||
Interest on S-T
|
610
|
994
|
104
|
0
|
||||||
borrowing
|
||||||||||
Total Disbursements
|
108,000
|
127,500
|
247,500
|
209,360
|
160,994
|
182,604
|
147,000
|
|||
Net
Monthly Change
|
65,500
|
-1,000
|
-127,500
|
-38,360
|
89,006
|
84,896
|
75,500
|
|||
Beginning
Cash Balance
|
22,000
|
87,500
|
86,500
|
20,000
|
20,000
|
20,000
|
94,542
|
|||
Additional Financing
|
61,000
|
38,360
|
(89,006)
|
(10,354)
|
0
|
|||||
Needed (Repayment)
|
||||||||||
Ending
Cash Balance
|
87,500
|
86,500
|
20,000
|
20,000
|
20,000
|
94,542
|
170,042
|
|||
Cumulative
Borrowing
|
61,000
|
99,360
|
10,354
|
0
|
0
|
|||||
Projections based on sale 20% higher than expected
Cash Budget
Nov
|
Dec
|
Jan
|
Feb
|
Mar
|
Apr
|
May
|
June
|
July
|
August
|
|
Sales
|
220,000
|
175,000
|
120,000
|
144,000
|
180,000
|
360,000
|
330,000
|
240,000
|
240,000
|
216,000
|
Collections:
|
||||||||||
Month of sales (10%)
|
24,000
|
28,800
|
36,000
|
72,000
|
66,000
|
48,000
|
48,000
|
|||
First month (60%)
|
87,500
|
60,000
|
72,000
|
90,000
|
180,000
|
165,000
|
120,000
|
|||
Second month (30%)
|
66,000
|
52,500
|
36,000
|
43,200
|
54,000
|
108,000
|
99,000
|
|||
Total collections
|
177,500
|
141,300
|
144,000
|
205,200
|
300,000
|
321,000
|
267,000
|
|||
Purchases
|
78,000
|
93,600
|
117,000
|
234,000
|
214,500
|
156,000
|
156,000
|
140,400
|
0
|
|
Payments
|
78,000
|
93,600
|
117,000
|
234,000
|
214,500
|
156,000
|
156,000
|
140,400
|
||
Cash
Receipts
|
177,500
|
141,300
|
144,000
|
205,200
|
300,000
|
321,000
|
267,000
|
|||
(collections)
|
||||||||||
Cash
Disbursements
|
||||||||||
Purchases
|
93,600
|
117,000
|
234,000
|
214,500
|
156,000
|
156,000
|
140,400
|
|||
Rent
|
10,000
|
10,000
|
10,000
|
10,000
|
10,000
|
10,000
|
10,000
|
|||
Other expenditures
|
20,000
|
20,000
|
20,000
|
20,000
|
20,000
|
20,000
|
20,000
|
|||
Tax Deposits
|
22,500
|
22,500
|
||||||||
Interest on S-T
|
923
|
1,325
|
198
|
0
|
||||||
borrowing
|
||||||||||
Total Disbursements
|
123,600
|
147,000
|
286,500
|
245,423
|
187,325
|
208,698
|
170,400
|
|||
Net
Monthly Change
|
53,900
|
-5,700
|
-142,500
|
-40,223
|
112,675
|
112,302
|
96,600
|
|||
Beginning
Cash Balance
|
22,000
|
75,900
|
70,200
|
20,000
|
20,000
|
20,000
|
112,454
|
|||
Additional Financing
|
92,300
|
40,223
|
(112,675)
|
(19,848)
|
0
|
|||||
Needed (Repayment)
|
||||||||||
Ending
Cash Balance 75,900
|
70,200
|
20,000
|
20,000
|
20,000
|
112,454
|
209,054
|
||||
Cumulative
Borrowing
|
92,300
|
132,523
|
19,848
|
0
|
0
|
|||||
Projections based on sales 20%
lower than expected:
Nov
|
Dec
|
Jan
|
Feb
|
Mar
|
Apr
|
May
|
June
|
July
|
August
|
|
Sales
|
220,000
|
175,000
|
80,000
|
96,000
|
120,000
|
240,000
|
220,000
|
160,000
|
160,000
|
144,000
|
Collections:
|
||||||||||
Month of sales (20%)
|
16,000
|
19,200
|
24,000
|
48,000
|
44,000
|
32,000
|
32,000
|
|||
First month (50%)
|
87,500
|
40,000
|
48,000
|
60,000
|
120,000
|
110,000
|
80,000
|
|||
Second month (30%)
|
66,000
|
52,500
|
24,000
|
28,800
|
36,000
|
72,000
|
66,000
|
|||
Total collections
|
169,500
|
111,700
|
96,000
|
136,800
|
200,000
|
214,000
|
178,000
|
|||
Purchases
|
52,000
|
62,400
|
78,000
|
156,000
|
143,000
|
104,000
|
104,000
|
93,600
|
0
|
|
Payments
|
52,000
|
62,400
|
78,000
|
156,000
|
143,000
|
104,000
|
104,000
|
93,600
|
||
Cash
Receipts
|
169,500
|
111,700
|
96,000
|
136,800
|
200,000
|
214,000
|
178,000
|
|||
(collections)
|
||||||||||
Cash
Disbursements
|
||||||||||
Purchases
|
62,400
|
78,000
|
156,000
|
143,000
|
104,000
|
104,000
|
93,600
|
|||
Rent |
10,000
|
10,000
|
10,000
|
10,000
|
10,000
|
10,000
|
10,000
|
|||
Other expenditures
|
20,000
|
20,000
|
20,000
|
20,000
|
20,000
|
20,000
|
20,000
|
|||
Tax Deposits
|
22,500
|
22,500
|
||||||||
Interest on S-T
|
297
|
662
|
9
|
0
|
||||||
borrowing
|
||||||||||
Total Disbursements
|
92,400
|
108,000
|
208,500
|
173,297
|
134,662
|
156,509
|
123,600
|
|||
Net
Monthly Change
|
77,100
|
3,700
|
-112,500
|
-36,497
|
65,338
|
57,491
|
54,400
|
|||
Beginning
Cash Balance
|
22,000
|
99,100
|
102,800
|
20,000
|
20,000
|
20,000
|
76,632
|
|||
Additional Financing
|
29,700
|
36,497
|
(65,338)
|
(859)
|
0
|
|||||
Needed (Repayment)
|
||||||||||
Ending
Cash Balance
|
99,100
|
102,800
|
20,000
|
20,000
|
20,000
|
76,632
|
131,032
|
|||
Cumulative
Borrowing
|
29,700
|
66,197
|
859
|
0
|
0
|
|||||
b. Harrison will not be able to retire the $200,000 note at the
end of June.
June
Ending
Sales Levels Cash Balance
Expected $94,542
+20% 112,454
-20% 76,632
4-12A.
a. Calculations of the sustainable rate of
growth for ADP, Inc. for each of the years 1999 through 2003 :
2003 2002 2001 2000 1999
Net
Income 150 110 90 70 60
Common
Equity 812 722 656 602 560
ROE 18.47% 15.24% 13.72% 11.63% 10.71%
Dividends 60 44 36 28 24
b 40% 40% 40% 40% 40%
g* 11.1% 9.1% 8.2% 7.0% 6.4%
b. Compare actual sales growth rates to the sustainable rate if
growth for each year.
2003 2002 2001 2000 1999
Sales 3,000 2,200 1,800 1,400 1,200
Sales
growth rate 36.4% 22.2% 28.6% 16.7% N/A
g* 11.1% 9.1% 8.2% 7.0% 6.4%
Difference 25.3% 13.1% 20.4% 9.7% N/A
A quick
review of ADP's balance sheets over the test years reveals a growing reliance
on debt financing. The firm's debt ratio
in 1999 was roughly 48% while it had grown to 70% in 2003. Thus, ADP has financed its growth with
increased debt financing.
4-13A.
a. Carrera Game Co.
2003 2002 2001 2000 1999
Liabilities 33,000 31,200 25,680 16,320 12,000
Assets 54,000 50,400 43,200 32,400 27,000
Debt
to Assets 61.1% 61.9% 59.4% 50.4% 44.4%
Net Income 3,000 2,800 2,400 1,800 1,500
Common Equity 21,000 19,200 17,520 16,080 15,000
ROE 14.3% 14.6% 13.7% 11.2% 10.0%
Dividends 1,200 1,120 960 720 600
b 40.0% 40.0% 40.0% 40.0% 40.0%
Sales 60,000 56,000 48,000 36,000 30,000
Sales
growth rate 7.1% 16.7% 33.3% 20.0% N/A
b. The sustainable rates of growth for
each of the last five years are calculated as follows:
g* 8.6% 8.8% 8.2% 6.7% 6.0%
Difference -1.5% 7.9% 25.1% 13.3% N/A
4-14A. a. Findlay's sales and
inventory balances are plotted in the figure below. Note that the relationship between the two
variables is very nearly linear.
However, the intercept for the relationship is not zero, consequently
the percent of sales projections are going to provide erroneous estimates of
future inventories.
b. The average of the inventories as a
percent of sales ratio for the last five years was 6.39%. Thus, we project inventories for a sales
level of $30 million to be $1,917,000.
That is,
Projected
Inventories = x
=
.0639 x $30 million = $1,917,000
Similarly, using the most recent
year's percent of sales (5%) we calculate inventories to be $1,500,000. That is,
Projected
Inventories = 
x
x
We can make a forecast of
inventories using the relationship observed between sales and inventories in
part a by sketching a line through the observed relationship and extrapolating
the line to sales of $30,000,000.
Using this graphical technique we
see that the level of inventories will probably be just over $1,300,000. The substantial difference in the percent of
sales forecast and the "true relationship" forecast is a result of
the implicit assumption made when using the percent of sales forecast. That is, the percent of sales forecast is
simply a linear extrapolation of inventories based on sales where the intercept
is assumed to be zero. As we saw in part
a, above, this assumption is not valid for this problem.
SOLUTION
TO INTEGRATIVE PROBLEM
Historical data for Phillips
Petroleum: 1986-92
1986
|
1987
|
1988
|
1989
|
1990
|
1991
|
1992
|
|
Sales
|
10,018
|
10,917
|
11,490
|
12,492
|
13,975
|
13,259
|
12,140
|
Net
Income
|
228
|
35
|
650
|
219
|
541
|
98
|
270
|
Earnings
per share
|
0.89
|
0.06
|
2.72
|
0.90
|
2.18
|
0.38
|
1.04
|
Dividends
per share
|
2.02
|
1.73
|
1.34
|
0.00
|
1.03
|
1.12
|
1.12
|
Number
of Common Shares
|
259,615,385
|
||||||
Current
Assets
|
2,802
|
2,855
|
3,062
|
2,876
|
3,322
|
2,459
|
2,349
|
 Total Assets |
12,403
|
12,111
|
11,968
|
11,256
|
12,130
|
11,473
|
11,468
|
Current
Liabilities
|
2,234
|
2,402
|
2,468
|
2,706
|
2,910
|
2,603
|
2,517
|
Long-term
Liabilities
|
8,175
|
7,887
|
7,387
|
6,418
|
6,501
|
6,113
|
5,894
|
Total
Liabilities
|
10,409
|
10,289
|
9,855
|
9,124
|
9,411
|
8,716
|
8,411
|
Preferred
Stock
|
270
|
205
|
0
|
0
|
0
|
0
|
359
|
Common
Equity
|
1,724
|
1,617
|
2,113
|
2,132
|
2,719
|
2,757
|
2,698
|
Total
Liabilities and Equity
|
12,403
|
12,111
|
11,968
|
11,256
|
12,130
|
11,473
|
11,468
|
1993
|
1994
|
1995
|
1996
|
1997
|
|||
Projected
Sales
|
13,000
|
13,500
|
14,000
|
14,500
|
15,500
|
||
1. Projected Net Income using the percent
of sales method.
1986
|
1987
|
1988
|
1989
|
1990
|
1991
|
1992
|
|
Sales
|
10,018
|
10,917
|
11,490
|
12,492
|
13,975
|
13,259
|
12,140
|
Net
Income
|
228
|
35
|
650
|
219
|
541
|
98
|
270
|
Net
Income/Sales
|
2.28%
|
0.32%
|
5.66%
|
1.75%
|
3.87%
|
0.74%
|
2.22%
|
Average
Net Income/Sales
|
2.406%
|
||||||
1993
|
1994
|
1995
|
1996
|
1997
|
|||
13,000
|
13,500
|
14,000
|
14,500
|
15,500
|
|||
Projected
Net Income
|
313
|
325
|
337
|
349
|
373
|
2. Projected total assets and current
liabilities
1986
|
1987
|
1988
|
1989
|
1990
|
1991
|
1992
|
|
 Sales |
10,018
|
10,917
|
11,490
|
12,492
|
13,975
|
13,259
|
12,140
|
Total
Assets
|
12,403
|
12,111
|
11,968
|
11,256
|
12,130
|
11,473
|
11,468
|
Current
Liabilities
|
2,234
|
2,402
|
2,468
|
2,706
|
2,910
|
2,603
|
2,517
|
TA/Sales
|
123.81%
|
110.94%
|
104.16%
|
90.11%
|
86.80%
|
86.53%
|
94.46%
|
CL/Sales
|
22.30%
|
22.00%
|
21.48%
|
21.66%
|
20.82%
|
19.63%
|
20.73%
|
Average
TA/Sales
|
99.54%
|
||||||
Average
CL/Sales
|
21.23%
|
||||||
1993
|
1994
|
1995
|
1996
|
1997
|
|||
Projected
Sales
|
13,000
|
13,500
|
14,000
|
14,500
|
15,500
|
||
Projected
Total Assets
|
12,940
|
13,438
|
13,936
|
14,433
|
15,429
|
||
Projected
C. Liabilities
|
2,760
|
2,866
|
2,972
|
3,078
|
3,291
|
3. Projected discretionary financing requirements for 1993-97.
1993
|
1994
|
1995
|
1996
|
1997
|
|||||||
Total
Assets
|
12,940
|
13,438
|
13,936
|
14,433
|
15,429
|
||||||
Current
Liabilities
|
2,760
|
2,866
|
2,972
|
3,078
|
3,291
|
||||||
Long-term
Debt
|
5,894
|
5,894
|
5,894
|
5,894
|
5,894
|
||||||
Preferred
Stock
|
359
|
359
|
359
|
359
|
359
|
||||||
Common
Equity*
|
2,720
|
2,754
|
2,800
|
2,858
|
2,940
|
||||||
Discretionary
Financing Needed**
|
1,207
|
1,565
|
1,911
|
2,244
|
2,945
|
||||||
* Common dividends = $1.12 x the number of
common shares outstanding in 1992 (
|
|||||||||||
Thus,
Common Equity (1993) = Common Equity (1992) + NI (1993) - Dividends (1993)
|
|||||||||||
 ** Discretionary Financing
Needed = Projected Total Assets - Current Liabilities - Long-term Debt -
Preferred Stock - Common Equity |
|||||||||||
Solutions to Problem Set B
4-1B.
2003 %
of Sales 2004
Sales 20,000,000 25,000,000
Net Income 1,000,000 2,000,000
Current Assets 4,000,000 20% 5,000,000
Net fixed assets 8,000,000 40% 10,000,000
Total Assets 12,000,000
15,000,000
Liabilities and Owner's Equity
Accounts payable 3,000,000 15% 3,750,000
Long-term debt 2,000,000
NA 2,000,000
Total Liabilities 5,000,000 5,750,000
Common stock 1,000,000 NA 1,000,000
Paid-in capital 1,800,000 NA 1,800,000
Retained earnings 4,200,000 6,200,000
Common equity 7,000,000 9,000,000
Total Liabilities and Equity 12,000,000
14,750,000
DFN
=
250,000
4-2B. a. %
Credit Sales 40%
Sales
February 100,000
March 80,000
April (estimated) 60,000
Accounts
receivable (3/31/04) 52,000
plus credit sales (April) 24,000
less
coll. from February (20,000)
less coll. from March (16,000)
Accounts
receivable (4/30/04) 40,000
b. Cash Sales 36,000
Collections
from February 20,000
Collections
from March 16,000
Realized
Cash during April 72,000
4-3B. Based upon the projections made, Simpson can expect to have total
assets next year equal to $1.75 million made up of the $1 million in fixed
assets plus $.75 million in current assets (.15 x 5m). These assets will be financed by known
sources of funding comprised of the firm's common equity, .85million ($.7
million + $.3 million. - $.15 million) plus payables and trade credit equal to
11% of projected sales ($.55 million) which totals $1.4 million. This leaves $.35 million, which will need to
be raised to meet the financing needs of the firm.
4-4B. Instructor’s Note: This is an introductory percent of sales
financial forecasting problem. Students
should be able to solve it after a first reading of the chapter.
(a) Projected Financing Needs = Projected Total Assets
=
Projected Current Assets + Projected Fixed Assets
=
(
x 25m) + 6m + .1m
x 25m) + 6m + .1m
=
$15,822,222
(b) DFN = Projected Current Assets + Projected Fixed Assets
- Present LTD
- Present Owner's Equity
-
[Projected Net Income - Dividends] - Spontaneous Financing
=
( x 25m) + 6m + .1m – 2m
–9.5m – (.05 x 25m - .6m) – (
x 25m)
x 25m) + 6m + .1m – 2m
–9.5m – (.05 x 25m - .6m) – ( x 25m)
DFN
= $1,588,889
(c) We first solve for the maximum level of
sales where DFN = 0:
DFN
= ( -.05 - ) Sales + 6.1m –2m –9.5m +.6m
-.05 - ) Sales + 6.1m –2m –9.5m +.6m
= .25556 Sales -4.8 million = 0
Thus,
SALES = $18,782,282
The largest increase in sales that
can occur without a need to raise "discretionary funds" is
$18,782,282
- $18m = $782,282.
4-5B.
Cash $ .03m Current Liabilities $.39m
Accounts Receivable .14m Long-Term Debt .81m
Inventories 1.0m Common Equity .80m
Net Fixed Assets .83m
$2.0m $2.0m
4-6B. (a)
CASH
BUDGET
DATA
January 100,000 May 275,000
February 110,000 June 250,000
March 130,000 July 235,000
April 250,000 August 160,000
The Carmel Corporation Cash
Budget Worksheet
Nov Dec Jan Feb Mar Apr May June July Aug
$220,000 $175,000 $100,000 $110,000 $130,000 $250,000 $275,000 $250,000 $235,000 160k
Collections:
First month (60%) 105,000 60,000 66,000 78,000 150,000 165,000 150,000
Second month (20%) 44,000 35,000 20,000 22,000 26,000 50,000 55,000
Total Collections 169,000 117,000 112,000 150,000 231,000 265,000 252,000
Purchases 70,000 77,000 91,000 175,000 192,500 175,000 164,500 112,000 0
Payments (1 mo lag) 70,000 77,000 91,000 175,000 192,500 175,000 164,500 112,000
Cash Receipts
(collections) 169,000 117,000 112,000 150,000 231,000 265,000 252,000
Cash Disbursements
Purchases 77,000 91,000 175,000 192,500 175,000 164,500 112,000
Rent 10,000 10,000 10,000 10,000 10,000 10,000 10,000
Other Expenditures 20,000 20,000 20,000 20,000 20,000 20,000 20,000
Tax Deposits 23,000 23,000
Interest on Short-Term 560 1,291 1,044 579
Borrowing
Beginning Cash Balance 22,000 84,000 80,000 20,000 20,000 20,000 20,000
Additional Financing 56,000 73,060 (24,709) (46,456) (57,895)
Needed (Repayment)
Ending Cash Balance $84,000 $80,000 $20,000 $20,000 $20,000 $ 20,000 $71,526
Cumulative
Borrowing 0 0 56,000 $129,060 $104,351 $57,895 0
(b) The firm will not have sufficient funds
to cover the $250,000 note payable due in July.
4-7B. Cash YES
Marketable
Securities NO
Accounts
Payable YES
Notes
Payable NO
Plant
and Equipment NO1
Inventories YES
1 The answer depends on whether or
not the firm has excess capacity. If
there is excess capacity, plant and equipment will not vary directly with the
level of firms sales. If there is no
excess capacity, plant and equipment will vary directly.
4-8B. (a) Current assets $20.00m Accounts payable $13.33m
Net fixed assets 15.00m Notes payable 1.67m
$35.00m Bonds payable 10.00m
Common
equity 10.00m
$35.00m
(b) Total financing requirements = $35m--however, spontaneous
financing accounts for all but the $1.67m increase in notes payable
(discretionary financing needed).
(c) See answer to question 4-1.
4-9B. Instructor’s Note:
This problem follows the text example very closely and provides an excellent
assigned exercise to accompany a first reading of the chapter.
(a) Estimating Future Financing Needs
Symbolic Logic Corporation (SLC),
Inc.
Projected Need for Discretionary
Financing
Present % of Sales Projected Level
Level ($5m) (Based
on $8m Sales)
Current Assets $2.5m = 50% .50 x $8m = $
4.0m
Net Fixed Assets $3.0m = 60% .60 x 8m = $
4.80m
Total Assets $5.5m $
8.80m
Accounts Payable $.1.0m = 20% .20
x 8m = 1.60m
Accrued Expenses $.5m = 10% .10
x 8m = .80m
Notes Payable* ------ ------- Plug
Figure 1.84m
Current Liabilities $1.50m $
4.24m
Long-Term Debt $2.00m No
Change $2.00m
Common Stock .50m No Change .50m
Retained Earnings** 1.50m $1.5m
+ (07 x
$8m) = $ 2.06m
Common Equity $2.00m $2.56m
Total Liabilities and Equity $5.50m $8.80m
*Notes payable is a balancing
figure which equals discretionary financing needed, DFN or: Total Assets - Accounts Payable - Accrued
Expenses - Long-Term Debt - Common Stock - Retained Earnings = $8.80m - 1.60m -
.8m – 2m - .5m – 2.06m = $1.84m.
**The projected level of retained
earnings equals the beginning balance of $1.50m plus net income for the period
(.07 x $8m).
(b) Before After
Current
Ratio = 1.67 times = .94
times
Debt Ratio = 64% =
71%
The growth in the firm's assets
(due to the projected increase in sales) was financed predominantly with notes
payable (a current liability). This led
to a substantial deterioration in the firm's liquidity (as reflected in the
current ratio) and an increase in its use of financial leverage.
(c) The slower rate of growth in sales would
have allowed SLC to finance a larger portion of the funds needed using retained
earnings.
4-10B.Instructor’s Note: This problem differs from the text discussion
of "discretionary financing needed" in that it relies on the
projected change in assets rather than the projected level of total
assets. Under these circumstances DFN = DTA - DSL - DRE where DTA = the projected change
in total assets, which is the amount of new financing needed (in total);
DSL = the projected change
in spontaneous liabilities; and DRE = the projected change in retained
earnings that will be available to finance a portion of the firm's needs for
new funds.
First, we estimate that the
projected change in assets during the coming year will be:
DTA = .40 DSales
= .40
($500,000) = $200,000
Thus, total new financing of
$200,000 must be obtained from somewhere during the next year to support the
growth in firm sales.
Next,
we project the change in spontaneous liabilities (DSL)
DSL = .15 x DSales
= .15
($500,000) = $75,000
Finally, we project new retained
earnings (DRE) that will be available to
help finance the firm's operations during the next year,
DRE = New Income -
Dividends
= .05
x Projected Sales - .04 x Projected Sales
= .01
($5,500,000)
DRE = $55,000
Discretionary
Financing Needed (DFN) can now be calculated as follows:
DFN = DTA - DSL - DRE
= $200,000
- 75,000 - 55,000
= $70,000
Note that this problem solution
works with the change in financing needs rather than totals. The same solution would result if we
projected total assets, total spontaneous financing, etc. However, in this problem we do not know the
existing levels of the assets, liabilities and owners' equity accounts. Thus, we cannot use this latter approach to
solve this problem.
4-11B.
Minimum Cash Balance = 25,000
Beginning Cash Balance = 28,000
Historical Sales and Base Case
Sales Predictions for Future Sales
January 120,000 May 225,000
February 160,000 June 250,000
March 140,000 July 200,000
April 190,000 August 220,000
Sales Expansion % = 0.00% Annual Interest
Purchases as a % Sales = 75% Rate = 12.00%
Collections: Current Mo. 1 Mo. Later 2
Mo. Later
30% 30%
40%
Cash
Budget for January thru July based on expected sales
Nov Dec Jan Feb Mar Apr May June July August
Sales 230,000 225,000 120,000 160,000 140,000 190,000 225,000 250,000 210,000 220,000
Collections:
Month of sales 36,000 48,000 42,000 57,000 67,500 75,000 63,000
First month 67,500 36,000 48,000 42,000 57,000 67,500 75,000
Second month 92,000 90,000 48,000 64,000 56,000 76,000 90,000
Total Collections 195,500 174,000 138,000 163,000 180,500 218,500 228,000
Purchases 90,000 120,000 105,000 142,500
168,750 187,500 157,500 165,000
Payments
90,000 120,000 105,000 142,500 168,750 187,500 157,500 165,000
Cash Receipts 195,500 174,000 138,000 163,000 180,500 218,500 228,000
(collections)
Cash
Disbursements
Payments for Purchases 120,000 105,000 142,500 168,750 187,500 157,500 165,000
Rent 12,000 12,000 12,000 12,000 12,000 12,000 12,000
Other Expenditures 20,000 20,000 20,000 20,000 20,000 20,000 20,000
Tax Deposits 26,500 26,500
Interest on Short-Term 0 173 564 545
Borrowing
Total Disbursements $152,000 $137,000 $201,000 $200,750 $219,673 $216,564 $197,545
Net Monthly Change $43,500 $37,000 ($63,000) ($37,750) ($39,173) $1,936 $30,455
Analysis of Borrowing Needs
Beginning Cash Balance 28,000 71,500 108,500 45,500 25,000 25,000 25,000
Ending Cash (No Borrow) 71,500 108,500 45,500 7,750 (14,173) 26,936 55,455
Needed
(Borrowing) 0 0 0 17,250 39,173 0 0
Loan Repayment 0 0 0 0 0 1,936 30,455
Ending
Cash Balance $71,500 $108,500 $45,500 $25,000 $25,000 $ 25,000 $25,000
Cumulative
Borrowing 0 0 0 $17,250 $56,423 $54,487 24,032
Cash
Budget for January thru July based on a 20% increase in sales
Nov Dec Jan Feb Mar Apr May June July August
Sales 230,000 225,000 144,000 192,000 168,000 228,000 270,000 300,000 252,000 264,000
Collections:
Month of sales 43,200 57,600 50,400 68,400 81,000 90,000 75,600
First month 67,500 43,200 57,600 50,400 68,400 81,000 90,000
Second month 92,000 90,000 57,600 76,800 67,200 91,200 108,000
Total Collections 202,700 190,800 165,600 195,600 216,600 262,200 273,600
Purchases 108,000 144,000 126,000 171,000
202,500 225,000 189,000 198,000
Payments
108,000 144,000 126,000 171,000 202,500 225,000 189,000 198,000
Cash Receipts 202,700 190,800 165,600 195,600 216,600 262,200 273,600
(collections)
Cash
Disbursements
Payments for Purchases 144,000 126,000 171,000 202,500
225,000 189,000 198,000
Rent 12,000 12,000 12,000 12,000 12,000 12,000 12,000
Other Expenditures 20,000 20,000 20,000 20,000 20,000 20,000 20,000
Tax Deposits 26,500 26,500
Interest on Short-Term 14 403 811 672
Borrowing
Total Disbursements $176,000 $158,000 $229,500 $234,514 $257,403 $248,311 $230,672
Net Monthly Change $26,700 $32,800 -$63,900 -$38,914 -$40,803 $13,889 $42,928
Analysis of Borrowing Needs
Beginning Cash Balance 28,000 54,700 87,500 25,000 25,000 25,000 25,000
Ending Cash (No Borrow) 54,700 87,500 23,600 -13,914 -15,803 38,889 67,928
Needed
(Borrowing) 0 0 1,400 38,914 40,803
Loan Repayment 0 0 0 0 0 (13,889) (42,928)
Ending
Cash Balance $54,700 $87,500 $25,000 $25,000 $25,000 $
25,000 $25,000
Cumulative
Borrowing 0 0 1,400 $40,314 $81,117 $67,228 24,300
Cash
Budget for January thru July based on a 20% decrease in sales
Nov Dec Jan Feb Mar Apr May June July August
Sales 230,000 225,000 96,000 128,000 112,000 152,000 180,000 200,000 168,000 176,000
Collections:
Month of sales 28,800 38,400 33,600 45,600 54,000 60,000 50,400
First month 67,500 28,800 38,400 33,600 45,600 54,000 60,000
Second month 92,000 90,000 38,400 51,200 44,800 60,800 72,000
Total Collections 188,300 157,200 110,400 130,400 144,400 174,800 182,400
Purchases 72,000 96,000 84,000 114,000
135,000 150,000 126,000 132,000
Payments
72,000 96,000 84,000 114,000 135,000 150,000 126,000 1320,000
Cash Receipts 188,300 157,200 110,400 130,400 144,400 174,800 182,400
(collections)
Cash
Disbursements
Payments for Purchases 96,000 84,000 114,000
135,000 150,000 126,000 132,000
Rent 12,000 12,000 12,000 12,000 12,000 12,000 12,000
Other Expenditures 20,000 20,000 20,000 20,000 20,000 20,000 20,000
Tax Deposits 26,500 26,500
Interest on Short-Term 318 418
Borrowing
Total Disbursements $128,000 $116,000 $172,500 $167,000 $182,000 $184,818 $164,418
Net Monthly Change $60,300 $41,200 -$62,100 -$36,600 -$37,600 -$10,018 $17,982
Analysis of Borrowing Needs
Beginning Cash Balance 28,000 88,300 129,500 67,400 30,800 25,000 25,000
Ending Cash (No Borrow) 88,300 129,500 67,400 30,800 -6,800 14,982 42,982
Needed
(Borrowing) 0 0 0 0 31,800 10,018
Loan Repayment 0 0 0 0 0 0 (17,982)
Ending
Cash Balance $88,300 $129,500 $67,400 $30,800 $25,000 $
25,000 $25,000
Cumulative
Borrowing 0 0 0 0 $31,800 $41,818 23,836
b. Halsey will not be able to retire the $200,000 note at the
end of July.
July
Ending
Sales Levels Cash Balance
Expected $25,000
+20% 25,000
-20% 25,000
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